“Give me a place to stand, and a lever long enough, and I will move the world.”
This issue of The Business Odyssey continues my discussion of infrastructure by introducing business infrastructure’s second component, Things. People act. Rules influence how to act. This however begs the question – act upon or with what? Things are the levers producing or enabling action. People use Things in specific ways (in accordance with Rules) to produce specific outcomes.
Business infrastructure uses many different levers taking on a variety of forms. Some levers are obvious and some not so obvious. I will share a few examples.
I recently advised a maker of precision machine parts on cash flow and capital structure. Among other things I was instrumental in helping the company restructure their balance sheet and secure an institutional private equity investor. This engagement required producing meaningful and reliable forecasts of future financial performance. My client produced parts for Tier One and Tier Two defense and aerospace contractors. These customers all maintained sophisticated ERP systems that scheduled the delivery of system components years in advance. This provided my client with a predictable and enviable order backlog. My client maintained its own ERP system that communicated electronically with its customers producing, in theory, an up-to-date backlog.
My client’s ERP system can serve as a powerful infrastructure lever capable of enhancing financial performance. Focusing exclusively on order backlog, for purposes of this example, I’ll offer a few thoughts on the specific ways this infrastructure lever could benefit the company. The obvious benefit is scheduling production. However, this backlog data combined with a reliable production schedule, not available when I started working with the client, could be used to dramatically reduce inventory carrying costs. In the case of this client, their inventory days were about 160 days. That’s an inventory turnover of about twice per year. Meaning that the company was devoting a significant amount of its working capital as inventory. This meant that the cash the company needed to satisfy payroll, suppliers and capital providers was unavailable. This required the company to pay more for its borrowed capital, subjected the company to penalties and made it impossible to take advantage of supplier discounts. The cost of protracted inventory days produced elevated capital costs, forfeiture of discounts, inefficient use of production resources and most importantly, lost revenue opportunities.
The business needed to manage its inventory more efficiently. A proper business infrastructure ensures that this happens and happens effectively. The lever to improve inventory utilization already existed but was unused – customer backlog data. The Company was failing to understand its infrastructure needs and cost it was incurring because its infrastructure was deficient.
I will point out that inventory efficiency is only one single example of the consequence of failing to understand the value of business infrastructure. This lever, backlog data, could and should be put to use in many other ways including forecasting and managing cash flow; managing expected growth by identifying revenue gaps, as well as anticipating and evaluating appropriate capital expenditures to name a few.
I use this as an example of a software system (a business infrastructure “Thing”) that was adopted, at no minor expense, to comply with its customers’ requirements. My client however failed to consider the other contributions this infrastructure could provide to improve competitive advantage, liquidity, and profitability.
This example is not unusual. There are many business practices and systems that businesses employ to comply with regulatory, tax, human resources or customer requirements. These systems are adopted mindlessly to comply without taking the time to think about how each might serve the business or in the context of an overall infrastructure architecture. This commonly produces redundancy, inefficiency, lost opportunity and in some cases even conflicting outcomes.
I’ll offer another more common example – tax compliance. Companies typically maintain voluminous records to ensure compliance with the morass of tax regulations. Another recent client conducted business nationwide as well as internationally. The business was required to comply with sales, use and income tax requirements from many different agencies. This particular client was very profitable and was thus a target of frequent audits. I need to digress for a moment to point out that being audited, while hardly a pleasant experience, is not necessarily caused by any misdeeds on the part of the company. Tax authorities often target successful companies for audits because the likelihood of collecting something is higher than auditing a company in trouble. I make this digression to emphasize that this client invested significantly to ensure tax compliance. During my consulting tenure I personally oversaw two separate tax audits and this company ran a clean ship.
My client had invested significantly in accounting systems, record retention and outside advisors to ensure rigorous compliance. However, tax compliance was considered a silo all to itself with no consideration of how that investment might be used to serve the business in other ways. The implications of this compliance mentality infected the business’s perspective by distracting executive leadership’s ability to see the bigger picture. An entire infrastructure, poorly architected I might add, had been established to ensure that the business was capable of responding to requests an auditor might make. There was a wealth of information being maintained to ensure tax compliance. Using some of this information I was able to identify the most profitable clients. Other information was used more rigorously to understanding the flow of cash and ultimately revealed the single most important measure of financial performance and will add millions of dollars to the bottom line every year going forward. The examples I’m using are meant to show the “ancillary” uses of data already maintained for the simple purpose of compliance. Needless to say, this more detailed understanding of the systems used to ensure tax compliance could be dramatically improved to free up peoples’ time to do other things, reduce expenditures on outside tax advisors and reduce the anxiety executives experienced every time tax issues arose.
There are many occasions where companies have assets whether software systems, data, locations, vehicles, machines or other Things, that are acquired and employed with no thought towards how they can or should be used to serve the overall purposes of the business.
I’ve spent the last few issue of The Business Odyssey dwelling on the topic of business infrastructure. My goal has been to address this seemingly nebulous concept by dissecting it into three component parts, People, Rules and Things. I don’t pretend that my discussion is exhaustive or complete. That was not my goal. My goal is to encourage middle-market executives, owners and directors to adopt a broader appreciation of the role business infrastructure serves. The middle-market business leader need not be an expert in business infrastructure. Moreover, it is an impossible and undesirable expectation to expect a business leader to be expert in every facet of inner workings – that’s the role of specialists. It is however the business leader’s responsibility to challenge infrastructure to serve the business and to know when exceptions to the routine require their decision.